Old-Economy Stocks Outpace Tech in Valuation! Goldman Sachs: Correction of the Magnificent Five Opens the Door to U.S. Equities

Some previously high-flying tech stocks have recently faced significant market sell-offs. However, Goldman Sachs believes that as valuations retreat, investors can reassess the timing for repositioning into tech stocks.

Market momentum trading encountered headwinds this summer. AI-related stocks, once heavily favored by capital flows, have undergone sharp corrections amid growing investor skepticism about their future prospects.

A team led by Goldman Sachs strategist Peter Oppenheimer pointed out that the recent market repricing of leading tech stocks reflects investor concerns over whether massive corporate capital expenditures will yield sufficient returns, resulting in a clear downward adjustment in price-to-earnings (P/E) ratios.

According to Goldman Sachs, the P/E ratio of the top five U.S. companies by market capitalization is now only slightly higher than that of the remaining 495 companies in the S&P 500, nearly eliminating the valuation premium they have enjoyed since 2017.

"This stands in stark contrast to the dot-com bubble era," said Oppenheimer. "Back then, valuations soared to even higher levels, but the subsequent P/E decline was driven by a collapse in stock prices. This time, the price correction has been relatively mild, while corporate earnings remain robust."

Globally, Goldman Sachs noted that the P/E premium of tech stocks relative to other sectors has declined from nearly 200% in the early 2000s to around 20% today. The leadership in tech gains has now shifted to hardware, particularly AI chip stocks, which are experiencing rapid earnings growth driven by AI demand.

However, Goldman Sachs said, "The market still worries about the cyclical nature of the chip industry and the sustainability of current earnings, which is why valuations have also been revised downward recently." Even though chip stock valuations have cooled, market expectations for future growth continue to rise—though they remain far below the levels seen during the dot-com bubble.

Traditional Sectors See Rising Valuations, Tech Returns to 20-Year Average

Goldman Sachs also pointed out that recent capital rotation has boosted the valuations of many 'old-economy' sectors previously overlooked by the market. For example, industrial stocks (XLI) are now valued above their past 20-year range, while tech stocks (XLK) have returned to their 20-year average level.

Moreover, sectors such as consumer staples, discretionary consumer goods, and healthcare now trade at valuations higher than those of information technology and communication services.

Goldman Sachs stated that although the largest sectors and large-cap stocks in the U.S. market have recently been adjusted, corporate earnings remain solid, causing the overall P/E ratio of U.S. equities to decline. Meanwhile, U.S. companies' return on equity (ROE) continues to significantly outperform that of other major global markets. China is the only major market where ROE remains below its historical average, with overall profitability still notably weak.

Goldman Sachs believes the valuation correction provides investors with an opportunity to reposition into U.S. equities, while also moderately diversifying across different regions.

Goldman Sachs: Momentum Stock Correction Is Normal, Rotation Volatility Expected to Ease

A team led by Ben Snider, Goldman Sachs' chief U.S. equity strategist, noted that historical patterns show momentum stocks typically undergo consolidation phases similar to the current one after rapid rallies.

Goldman Sachs believes that, given historical trends and the significant deleveraging by hedge funds and ETF investors, the recent volatility from sector rotation is likely to gradually subside over the coming weeks.

Adam Parker, founder and CEO of Trivariate Research, believes that portfolios with higher diversification may now hold a competitive advantage.

The firm compared the performance of portfolios holding 25, 50, 75, and 100 stocks since 2000. It found that even with stock-picking ability, since 2019, highly concentrated 25-stock portfolios have been less stable in both volatility and performance compared to 50- or 75-stock portfolios.